Friday, January 22, 2016

Pundits keep a close watch on the U.S. Federal Reserve as it
meets to raise interest rates after seven years of effectively zero rates. Yet the
reality is that many Americans know little about interest rates, and much less about
the implications of a rate hike for their finances! This was one key finding from the recently
released S&P Global FinLit Survey, gathered
with the support of McGraw Hill Financial.

The goal of the international study was to compare adult
financial literacy levels across more than 140 nations. Financial literacy was
measured using questions assessing basic knowledge of four fundamental
concepts: numeracy or capacity to do simple calculations in the context of
interest rates, interest compounding, inflation, and risk diversification. Respondents
were deemed “financially literate” if they could correctly answer three of the four
questions. The
Global Financial Literacy Excellence Center
helped design the survey and analyze the results.

Staggeringly, we found that only one in three adults is financially literate around the world. While
Americans far a bit better, only a little more than half of US adults scores
this well, a finding that bodes ill for one of the world’s most advanced
financial markets.

More importantly, our research has also identified what
people don’t
know about their finances. One giant void
has to do with compound interest, despite the fact that many are quite vulnerable
to interest rate changes. For example, when combining information with the
Global Findex data, we find only 66% of Americans who hold credit cards understand
interest compounding. In Brazil, Latin America’s largest economy, only about
half of credit-card holders can accurately answer our interest-compounding
question. Similar results apply to borrowers elsewhere. The logical implication
is that, whatever the Federal Reserve decides, most people will snooze through
the news. This, of course, can be dangerous to debtors everywhere.

There are a few financial concepts that people do tend
to understand, particularly inflation. Naturally, this topic is one where
experience matters: having struggled mightily with hyperinflation in the
late1980s and early 1990s, two-thirds of Argentinians can answer an inflation question
accurately. Similar patterns are observed in Georgia, Bosnia and Herzegovina,
and Peru, all of which also suffered under hyperinflation in the past. By
contrast, only half of Japanese adults understand the corrosive power of
inflation, having suffered deflation over the past few decades. In the U.S.,
the figure is just shy of two thirds (63%).

Monetary policy affects households and household finances,
yet what people know about some of its levers is limited. As interest rates
start rising, some people will learn about interest compounding. But this begs
the question: should experience alone
be our teacher?

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About Me

Annamaria Lusardi is the Denit Trust Endowed Chair of Economics and Accountancy at the George Washington School of Business. Previously, she was the Joel Z. and Susan Hyatt Professor of Economics at Dartmouth College. She has taught at Dartmouth College, Princeton University, the University of Chicago Public Policy School, the University of Chicago Booth School of Business and the Graduate School of Business at Columbia University. From January to June 2008, she was a visiting scholar at Harvard Business School. She has advised the U.S. Treasury, the U.S. Social Security Administration, the Dutch Central Bank, and the Dartmouth Hitchcock Medical Center on issues related to financial literacy and saving. She is the recipient of the Fidelity Pyramid Prize, awarded to authors of published applied research that best helps address the goal of improving lifelong financial well-being for Americans. She holds a Ph.D. degree in Economics from Princeton University.